Research Discussion Papers, Bank of Finland
No 8/1998:
Technological Transformation and Nonbank Competition in a Model of Retail Banking Oligopoly
Jukka Vesala ()
Abstract: A model of banking competition is developed, in which
diffusion of electronic banking (eg pc and phone banking) and nonbank
competition (eg mutual funds, retail stores and insurance firms) are
studied as factors that diminish the benefits of branch and ATM networks in
terms of enhanced demand and pricing power. A structural increase in price
competition, a decrease in the variation of loan and deposit rates across
banks and a decline in the optimal numbers of branches and ATMs is shown to
result. Competition increases permanently unless banks are able to
redifferentiate from rivals through novel innovation that compensates for
the reduced value of network differentatiation. Capacity collusion is shown
to reduce the sizes of branch and ATM networks as well as banks' markups of
loan and deposit rates over the money market rate and respective marginal
operating costs. ATM compatibility reduces the total number of machines and
under certain conditions raises deposit rates. Under strategic
complementarity technological transformation and nonbank expansion enhance
the transmission of monetary policy into lending rates, as well as into
deposit rates, because banks' incentives to change their rates and the
sizes of optimal responses increase with respect to changes in the money
market rate. If these trends continue to be more pronounced on the deposit
side, loan rates will become more insulated from deposit market events and
the volatility of banks' netinterest income will increase.
Keywords: retail banking; price competition; nonprice competition; technological transformation; monetary policy transmission; (follow links to similar papers)
59 pages, May 11, 1998
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